Multiple Choice Question 140 Skysong Company is considering buying equipment for

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Multiple Choice Question 140

Skysong Company is considering buying equipment for $300000 with a useful life of 5 years and an estimated salvage value of $16000. If annual expected income is $28000, the denominator in computing the annual rate of return is

Multiple Choice Question 101

Blue Spruce Inc. is comparing several alternative capital budgeting projects as shown below:

Using the profitability index, how many of the projects are acceptable?

Multiple Choice Question 81

Cullumber, Inc. is considering the purchase of a new machine for $450000 that has an estimated useful life of 5 years and no salvage value. The machine will generate net annual cash flows of $78750. It is believed that the new machine will reduce downtime because of its reliability. Assume the discount rate is 8%. In order to make the project acceptable, the increase in cash flows per year resulting from reduced downtime must be at least

Explanation / Answer

1.

Annual rate of return = Average annual profit/Average investment

                               = Average annual profit/ [(Purchase price + salvage value)/2]

                               = $ 28,000/ [($ 300,000 + $ 16,000)/2]

                               = $ 28,000/ [($ 316,000)/2]

                               = $ 28,000/$ 158,000 = 0.17721519 or 17.72 %

The denominator in computing annual rate of return is $ 158,000.

Hence option “$ 158,000” is correct answer.

2.

Profitability index = Present value of future cash flow/Initial investment

For Project A, Profitability index = $ 112,000/$ 102,000 = 1.1

For Project B, Profitability index = $ 132,000/$ 142,000 = 0.93

For Project C, Profitability index = $ 222,000/$ 182,000 = 1.22

Project A and C is acceptable as PI >1. Two projects are acceptable.

Hence option first “2” is correct answer.

3.

NPV = C x PVIFA (i, n) – Initial investment

         = $ 78,750 x PVIFA (8 %, 5) – $ 450,000

        = $ 78,750 x 3.993 - $ 450,000

         = $ 314,448.75 - $ 450,000

         = - $ 135,551.25

For acceptance of project, NPV should not be negative.

Minimum increase in cash flow in order to be the project acceptable is:

$ 135,551.25/3.993 = $ 33,947.22 or $ 33,947 per year

Hence option “$ 33,947” is correct answer

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